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4/27/2016

Inside Money In SERE

Like I wrote in the last post, I don't normally post on this blog at all. But I have a story from the spouse of an undergraduate student that I'd like to be able to refer future students to. I don't really have a place to put it online, so I'm putting it here.

Occasionally on this blog I have accepted posts from students explaining how economics relates to specific aspects of their job. I don't encourage that because it's talking shop.

Anyway, I mostly teach principles of macroeconomics. In there, we talk about money. One of the simpler topics, but still a new one to many students, is that money is broader than currency. For example, checks are money, but they aren't currency.

A more nuanced topic is inside vs. outside money. Outside money is currency (printed by the government, or its representatives) and reserves (issued by central banks). Inside money is everything else: checks, savings accounts, CDs, repurchase agreements, and so on.They're called inside and outside because inside money is created by us doing our thing inside the financial system, while outside money comes from outside the financial system. Most students (and many people out in the public) think outside money is a lot more important than it actually is. As I sit here, I'm trying to recall, but I don't think I've used outside money since the weekend, but I've payed bills all week with inside money.

An even subtler topic is that people will create inside money out of anything handy, if there isn't enough inside or outside money around to suit their needs. This is what we do when we write each other IOU's.

The classic textbook example of this is POW's using cigarettes as money in the camps. So I told my undergraduates that story (which was written up in a famous paper about 70 years ago by an economist who ended up as a POW in Germany in World War II). When I was finished, a student raised her hand and said: they still do that in survival school in the Air Force. I was a bit shocked, but she explained that her husband had been through it. He agreed to let me interview him about it, and here's what I got. This is MG's story.

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Air Force pilots are required to do survival training: 3 stints, once in their career, for about 20 days in total.

One of those exercises is called SERE: Survival.Evasion.Resistance.Escape. The training is done at a remote location in Washington. A team of about 8 pilots goes through the training together. They are abandoned in the wilderness one morning with 2 MRE's each. They need to survive for a week. They are also allowed to bring a small pack with extra goodies.

MG was told by pilots who had been through the training before to bring cigarettes. MG told them he didn't smoke. The veteran pilots told him it didn't matter: pilots used cigarettes as money during SERE.

So, MG brought 5 packs. Other pilots brought even more. Many of the cigarettes in the group were quickly smoked by the smokers.

That's one thing I tell principles students about what gets used as inside money: it should not be readily consumable. Other features are more obviously related to money: small, light, of fairly certain quality, divisible into small enough units, low rate of depreciation, and so on.

After a while, inflation set in. The price of a bag of skittles eventually rose to 3 cigarettes. Cigarettes were also traded on the spot for (actual) currency, or in exchange for jobs during SERE training.

Cigarettes were even traded for large sums of money to be repaid after training was over. This is very much like how repurchase agreements work in the real world: a firm gives up an asset to another firm for money today, with an agreement to repurchase at a known price on a future date (in the meantime the buyer gets to keep any income generated, plus the price difference). Repurchase agreements are often done in the real world in multi-billion dollar transactions. In the SERE training, the exchange rate hit 1 cigarette handed over immediately for $100 payable in cash when they returned to base. MG saw a transaction like that finalized.

4 comments:

I guess I've never thought about it this way, but we have a similar inside money system in our household. My very creative wife came up with a unique way of encouraging our children to do good deeds around the house. This could be as simple as playing nice with each other, or as big as cleaning up after dinner without being asked. The payment to our children for performing these good deeds were nicknamed "good thing sticks". Every time my wife or I spot one of our children doing a good deed, we reward them with a Popsicle stick, also known as "good thing sticks". Each child has their own red solo cup where their Popsicle stick savings accounts grow as they earn them. Once a month we count them up and issue each child a quarter for each Popsicle stick. We then take them to the a dollar store where they get to shop with their small sum of hard earned money. After reading your post, I immediately told my wife that she had created inside money, and she of course looked at me like I was crazy. As a result of our inside money system, we have perfectly well behaved children that cause us no trouble, or a least that is the goal.

FWIW: I like your system. I have tried to do stuff like that at our home, but I get "the look" that means all economists are bad guys who are only concerned about money.

I would say that this is not quite inside money. To be "money" it has to be exchangeable between two people (parents and kids in this case), both ways (so you're missing kids to parents), and most importantly, in principle it has to be transferable to a third party (so, from the kid that earned them to a kid that didn't).

Now, maybe you do all have all those details in your home, and you do have inside money. But from what I understand you have something more like scrip. Scrip is the "money" that used to be issued to employees in factory towns and military bases. The scrip could only be readily exchanged with only certain other parties — like the company store or PX.

One of the first thoughts that came to my mind was if this "economy", that the pilots experienced, was an example of deflation, hyperinflation, or both? Obviously, the cigarettes were both a currency and a commodity. The cigarettes became a deflationary currency since the pilots continued to smoke them; thus, reducing the number of available cigarettes. However, the cigarettes were also a rare commodity that were finally traded for $100 per cigarette. (What a fantastic return on investment, if the seller of the cigarette could eventually collect on the "note".) This appears to be a good example of hyperinflation. Now, I can't think of many examples of where one would see both hyperinflation and deflation of currency. I find this an extremely interesting "micro-economy" that my be hard to reproduce in real world economics. Traditionally, hyperinflation reduces the value of currency. However, in Dr. Tufte's example the currency (cigarettes) became much more valuable in the state of hyperinflation.

Dr. Tufte, thank you for sharing such an interesting story! Your posting led me to read about the WWII POW's micro-economy and the effects that the Red Cross and German Guards played into it. Have a wonderful summer!

FWIW: I was told that it was the senior officer in this group that offered the $100, and that it was paid immediately upon return to base.

I think Anthony Graham is confused on terminology here. When the cigarettes are consumed, this does not make them deflationary. It does make their quantity diminish, but that is inflationary. So there's no contradiction.

OK, now if you've got that down, it's regular paper currency that is suffering hyperinflation here, not the commodity currency. Every price can be thought of in its typical form, and also in its reciprocal. So here, that's 1 cigarette for $100, or 1 dollar for 1/100 of a cigarette. The hyperinflation occurs in each, but the number you look at is not necessarily getting larger. It's a matter of the perspective you choose.